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The Year of Unexpected Shocks

I’ve spent a lot of time staring at my monitors this year and scratching my head, dumbfounded. Harry calls it a “market on crack.” I’m not sure what words I would use to describe it, but 2016 has certainly kept me guessing.

I shouldn’t complain. We made good money in Boom & Bust this year, and most of our major macro trends played out as we expected, even with all of the unexpected shocks. But this is definitely a year that I expect market historians to pick apart for a long time to come.

Let’s take a look at the year that has passed, draw some lessons from it, and put together a game plan for 2017.

2016 started with one of the very worst Januarys in history, driven mostly by the upheaval in the energy market. But the Fed’s rate hike at the end of last year played a part too, particularly in interest-rate-sensitive sectors like REITs. Then, the Fed backed off, energy prices found a bottom, and the stock market recovered… and went on to rise into the summer.

And that’s when it really got weird.

British voters opted to leave the European Union, and we got the dreaded Brexit… which was supposed to be the first domino to fall in the collapse of the EU. Well, the British pound took a hit, but British stocks went on to rally to new highs after taking a brief pause.

And then came Donald Trump. Our soon-to-be president was given virtually no chance of winning the election, even up until election day. And as his victory became more and more apparent, Dow futures collapsed by over 800 points. But the very next day, the market embraced the victory, and stocks have been rallying ever since.

So what conclusions do we draw from this?

To start, the conventional wisdom you read in the news is often wrong. And it’s not that the talking heads are necessarily stupid, mind you, and their reasoning often makes perfect sense. But they’re still often wrong because the world is ridiculously complex. And when you add in the emotional aspects of the market – attempting to predict how people will “feel” and react – it becomes virtually impossible to make sense of it.

Simply put, you can’t make sense out of market emotions any more than you can explain love or romantic attraction.

Media talking heads also often fail to consider how their words and actions affect the world they’re trying to predict. If “everyone” becomes convinced that a certain narrative will play out, then they’ve likely already traded on it, and it’s likely already reflected in market prices.

As Adam wrote recently, many of the greatest investors – think Warren Buffett or Cliff Asness – don’t read the news, or at least they don’t allow it to affect their investment decisions. Instead, they stick to investment strategies that work and tune out distractions.

So, how can we put these ideas to work in 2017?

To start, in Boom & Bust we’re sticking to our demographic macro themes. Yes, politics matter. But assuming nuclear bombs don’t start falling out of the sky, they really don’t matter as much as you might think, or at least in the ways you might think.

For example, the George W. Bush tax cuts were credited with creating newfound interest in dividends, which used to be taxed at higher rates. But was it tax cuts that spurred interest in dividends, or the coming retirement of the baby boomers and their ever-increasing need for income?

By following our macro themes in Boom & Bust, we’re holding our long positions in the dollar and our short positions in gold and the Japanese yen. And while we’re currently making money betting against bonds, we’re a lot more likely to reverse that trade and go long on bonds at some point relatively early in 2017.

Our demographic models suggest that we still have a couple more years of deflation, or at least very low inflation, and nothing coming out of Washington is likely to change that.

I’ll also look to continue grabbing cash-flow opportunities as they become available in my income service, Peak Income. Closed-end funds are trading at some of their deepest discounts since 2008 right now. We saw similar conditions around this time last year, and closed-end funds as an asset class went on to enjoy a spectacular rally from February through late summer.

Might we have a repeat in 2017? We shall see. But while we’re waiting, we can occupy ourselves with the steady stream of monthly dividends.

Best wishes in the New Year,

Charles
Portfolio Manager, Boom & Bust

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